Javatpoint Logo
Javatpoint Logo

Fiscal Policy Definition

Fiscal policy uses government payout and taxation to change the country's economy. It is one of the two main aspects of macroeconomic policy; the other is monetary policy. Fiscal policy deals with spending and government taxes, whereas Monetary policy focus on interest rates and money supply. While the central bank handles monetary policy, fiscal policy is controlled by the government. The government makes all decisions in the case of Fiscal policy.

The fiscal policy objectives are to promote economic stability, growth, and development. Governments use fiscal policy to achieve these objectives by influencing spending and taxation.

Fiscal Policy Definition

The Main Objective of Fiscal Policy

  • Stabilization of the Economy: Fiscal policy can bring stability by decreasing instability in economic activity. When the country faces an economic downfall, the government can increase its spending on public actions and reduce taxes to stabilize economic growth. In the same way, when the country experiences financial increment, the government can reduce its spending on shared activities and increase public taxes to stabilize economic growth. In this way, fiscal policy helps a country's economy to stay on a stable path.
  • Total Employment: Fiscal policy can help generate employment by increasing government spending on the field that creates more employment, arranging public awareness programs, and opening training centres to train people according to the industry's current working environment so they can easily find a job. In this way, fiscal policy helps create employment and reduce unemployment.
  • Price Stability: Fiscal policy can also maintain price stability by controlling inflation. When the economy is experiencing high inflation levels, the government can use contractionary fiscal policy to reduce demand and lower prices. Conversely, during deflation or low inflation periods, the government can use expansionary fiscal policy to increase demand and raise prices. This trick directly helps in maintaining price stability in the economy.
  • Economic Growth: Fiscal policy directly affects and cooperates with the economic growth of a country by increasing government spending on research and development, education, and infrastructure. By investing in these areas, the government can help to create a more productive and competitive economy. A more effective and competitive economy plays a significant role in turning a developing country into a developed country.
  • Redistribution of Income: Fiscal policy can also be used to redistribute income by adjusting taxation policies. For example, the government can use progressive taxation to tax higher-income earners at a higher rate and use the revenue to fund social programs that benefit lower-income earners. Rich people earn more, so they can pay high taxes, whereas a poor or lower-middle-class family cannot generate a much more significant amount of tax that can affect funding as rich people do.

Fiscal policy objectives are to achieve a stable and growing economy that benefits all citizens. By using fiscal policy wisely, governments can help to create an environment that promotes economic prosperity and social well-being. When the economy is in a recession or downfall, governments can use fiscal policy to stimulate growth by increasing government spending or cutting taxes. By increasing government spending, more money flows into the economy, creating jobs and increasing demand for goods and services. Reducing taxes also puts more money in the hands of consumers, which they can then spend or invest, further boosting economic activity.

On the other hand, when the economy is overheating, and inflation is a concern, governments can use contractionary fiscal policy to slow down growth. This can be achieved by reducing government spending or increasing tax amounts. Reducing government spending means less money flows into the economy, which can help reduce inflationary pressures.

Increasing taxes also take money out of the hands of consumers, reducing demand for goods and services, which can help control inflation. Although the increase in economic growth brings a lot of changes in the country, like higher income, reduced poverty, better education, increased life expectancy, increased government finance, and much more, it is a saying that excess of anything is always harmful. In this case, the excess economic growth can lead to congestion, inequality, pollution, and several other negatives. As mentioned above, fiscal policy helps avoid excess growth in the country's economy by decreasing government expenses.

Fiscal policy can also address specific issues or challenges facing the economy. For example, during a recession, the government may introduce a fiscal stimulus package to help boost demand for goods and services, create jobs, and prevent the economy from sliding further into recession. Similarly, in times of crisis, such as a natural disaster or a pandemic, the government may introduce targeted measures to support affected industries, businesses, and individuals. This can include decrement in government taxes, providing funding to Worsley-affected areas, and contributing partnerships.

Fiscal policy actions can take a while to influence the economy significantly. The results might vary depending on several variables, including the impact size, consumers' and businesses' responsiveness, and the present inflationary pressures. As a result, it is crucial for decision-makers to thoroughly consider the economic situation before selecting the proper fiscal policy actions that are likely to have the desired outcome. Many difficulties need to be addressed by the government during the implementation of the fiscal policy. Some of them are

  1. Timing: Timing is the major challenge of fiscal policy. The changes and actions must be implemented within a given period. Else, no effect will be caused by the fiscal policy to maintain economic balance.
  2. Amplitude: Amplitude of the effect of fiscal policy is the second major challenge. If the amplitude of the actions and changes is strong enough to control the downfall in the economy, then only it is helpful for the economic growth of the country. Governments can use fiscal policy to help them achieve goals, including balancing the economy, encouraging growth, and increasing employment. Fiscal policy, like all other policymaking tools, has benefits and drawbacks. We will look at some of the advantages and disadvantages of fiscal policy in this article.

Advantages of Fiscal Policy

  • Easily Adjustable: Modifying the fiscal policy to consider shifting economic conditions is simple. For instance, the government can utilize fiscal policy to boost the economy during a period of weakness by raising spending or lowering taxes. Similarly, it can restrict demand during periods of high inflation; the government can do so through fiscal policy by raising taxes or cutting spending.
  • Precision: Fiscal policy can be targeted to specific groups or sectors of the economy. For example, the government can use fiscal policy to provide targeted tax breaks or subsidies to industries that need support. Government can increase taxes on the part of the population earning more than a specified limit or rich class people. They can afford high tax payments, but low-income people need help too.
  • Stimulating Economic Growth: Fiscal policy can boost economic growth by raising money spent on construction projects or job generation initiatives. This may boost employment by creating training centres, arranging general awareness programs, and raising consumer demand for goods and services.
  • Income Redistribution: By changing taxation laws, fiscal policy can be utilized to redistribute income. The government may, for instance, use progressive taxation to charge higher-income earners a greater antitax tax rate than the money raised to pay for social programs that assist lower-income earners.

Disadvantages of Fiscal Policy

  1. Time Lags: If we think implementing the fiscal policy and accepting it by the public is easy and can be done quickly, then we need to be corrected. There may be a long-time lag between the execution of fiscal policy and its impact on the economy. This means that the economy may have already undergone unforeseen changes by the time budgetary policy measures take effect.
  2. Crowding Out: When the government increases its spending, it may lead to higher interest rates and less private investment. This is known as crowding out and can limit the effectiveness of fiscal policy. The crowding-out effect describes a circumstance in which rising public spending results in falling private-sector spending. When the government borrows funds from the private sector to fund its spending, interest rates rise, and the quantity of funds available for private investment decreases.
    Consider a scenario where the government funds a new infrastructure initiative, such as highway construction. The government issues bonds and takes out loans from the private sector to pay for this project. Because of this, interest rates rise, and borrowing money becomes more costly for businesses and people. As a result, companies and individuals may postpone purchases or investments due to the high cost of borrowing, which could result in a decline in private-sector spending. In this scenario, the government's increased spending on the infrastructure project has crowded out private sector spending. Businesses and individuals need more money to invest or spend on other projects.
  3. Budget Losses: Fiscal policy can lead to losses if the government spends more than it collects in taxes. Higher levels of government debt could arise from this, constrict future fiscal policy options, and raise interest rates.
  4. Political Influence: Political considerations can influence fiscal policy decisions, which may not always align with the country's best economic interests. The decision might be the result of the self-interest of a leader or political party.

There are positive and negative aspects of fiscal policy. Governments can use compromises between different policy alternatives to achieve their economic goals. Still, policymakers must carefully weigh these trade-offs and their economic impact and accordingly make decisions.

Case Study: Fiscal Policy in Japan

The Case of Abenomics (2012)

Japan is a developed nation with economic challenges in recent years, including a stagnant economy and low inflation levels. In response to these challenges, the Japanese government has implemented various fiscal policy measures to stimulate the economy and promote growth.

One example of fiscal policy in Japan is implementing the "Abenomics" program in 2012. This program, named after Prime Minister Shinzo Abe, aimed to achieve economic growth through fiscal policy, monetary policy, and structural reforms. Prime Minister Shinzo Abe started this policy to increase the country's money supply, government spending on various activities, and much more. This was the second time Shinzo Abe became Japan's prime minister. 'ABENOMICS' can be cut into two parts: ' abe' + 'economics,' meaning the reforms and policies that prime minister Shinzo Abe implemented.

Fiscal policy measures under Abenomics included an increase in government spending on public works projects and social programs, as well as a decrease in corporate tax rates. These measures were designed to increase demand and promote economic growth.

Abenomics' outcomes have been conflicting. In the short term, the program enhanced the country's economic development. Still, it needed to address some of the fundamental problems faced by the Japanese economy, such as an ageing population and low productivity.

In response to these challenges, the Japanese government has continued to implement fiscal policy measures. In 2020, the government approved a $239 billion stimulus package to combat the economic effects of the COVID-19 pandemic. This package included measures such as cash payments to citizens, subsidies for small businesses, and increased government spending on healthcare.

The effectiveness of these measures is still being evaluated. While the stimulus package did lead to a temporary increase in economic growth, it also increased Japan's already high government debt levels. Critics argue that the government should focus on long-term structural reforms rather than short-term stimulus measures.

In short, the case of fiscal policy in Japan highlights the challenges policymakers face in using fiscal policy to promote economic growth. The set of reforms and procedures that prime minister Shinzo Abe implemented was discussed in this program. While fiscal policy measures can be effective in the short term, they may not address underlying structural economic issues. As such, policymakers must carefully consider the potential trade-offs between short-term stimulus measures and long-term structural reforms.


Fiscal policy is a vital tool for macroeconomic management since it assists in stabilizing the economy and promoting the economic growth of a country and development. The economic environment, the timing and broadness of the actions, and any possible trade-offs between the goals of the various policies must all be carefully considered because it is a challenging and complicated policy area. By effectively implementing fiscal policy, governments can help to ensure a strong and prosperous economy for their citizens. Fiscal policy objectives are to achieve a stable and growing economy that benefits all citizens. By using fiscal policy wisely, governments can help to create an environment that promotes economic prosperity and social well-being.

Youtube For Videos Join Our Youtube Channel: Join Now


Help Others, Please Share

facebook twitter pinterest

Learn Latest Tutorials


Trending Technologies

B.Tech / MCA